Will the new markets tax credit stimulate low-income communities?

• Author: Lederman, Alan S.
• Position: Part 2

Part I of this two-part article, in the last issue, explained the goals of and qualifications for new markets tax credits (NMTCs).

Part II discusses uses of taxpayers' capital contributions, credit recapture, other Federal tax incentives and limits on NMTC use.

In the last issue, Part I of this two-part article addressed new markets tax credit (NMTC) status, allocations and investments. The second part, below, discusses uses of taxpayers' capital contributions, recapture, other Federal tax incentives and limits on use.

Permissible Investments

For equity investors in a community development entity (CDE) to qualify for NMTCs, the CDE must use 85% (substantially all) of contributed capital to make qualified low-income community investments. Sec. 45D(d)(1) defines "qualified low-income community investments" to include any:

1. Capital investment in a qualified active low-income community business (qualified business).

2. Loan made directly to such a qualified business.

3. Equity in (or loan to) another CDE.

4. Loan to a qualified business or CDE originated by another CDE and purchased from the originating CDE.

Sec. 45D (d)(1) also includes financial counseling to businesses in (and residents of) low-income communities.

Qualified Business

To generate NMTCs for its equity investors, a CDE making loans to or investing equity in a non-CDE entity (or buying from another CDE a loan originally made by that CDE to a non-CDE entity) must generally ensure that the non-CDE entity is a "qualified active low-income community business" (defined in Sec. 45D(d)(2)). Sec. 45D(d)(2)(A) permits a qualified business to be organized as a partnership (including a multiple-member limited liability company (LLC)), a nonprofit corporation or a for-profit C or S corporation.

In addition, Sec. 45D(d)(2)(B) states that businesses organized as proprietorships (presumably including single-member LLCs (SMLLCs)) can qualify, if the proprietorship would meet the requirements if separately incorporated. Similarly, Sec. 45D(d)(2)(C) provides that a portion of a qualified business conducted in several locations can qualify. Apparently, borrowers that are qualified subchapter S subsidiaries and SMLLCs with a corporation or partnership sole owner can be qualified active low-income community businesses if their sole owner qualifies under Sec. 45D(d)(2)(A) or if they separately qualify under Sec. 45D(d)(2)(C).

Sec. 45D(d)(3) permits most types of businesses to qualify. While commercial rental buildings (e.g., shopping centers, offices and warehouses) meet the requirements regardless of the business's commercial tenants, unimproved real estate holdings do not qualify. Sec. 45D(d)(3), incorporating Sec. 1397C(d), makes certain types of businesses ineligible, including rental housing, developing or holding of intangibles for license (thus excluding some software businesses), firms valued in excess of $500,000 and liquor stores and other facilities described in Sec. 144(c)(6)(B).

Percentage Tests

Under Sec. 45D(d)(2)(A) and Temp. Kegs. Sec. 1.45D-1T(d)(4), a business must have certain links to low-income communities to be a qualified active low-income community business. At least 40% of the tangible real or personal property owned or leased by the business (valued at original cost for owned property and any reasonable valuation for leased property) must be located within any low-income community. At least 40% of the wages paid to employees must be for services performed by the entity within any low-income community. Moreover, unless either the low-income community tangible property percentage or wages percentage is at least 50%, at least 50% of gross income must be derived from the active conduct of a qualified business within any low-income community.

The 40% tests may be difficult to meet for many businesses whose headquarters and employees are located within a low-income community, but which provide services outside such communities (e.g., construction, guard, janitorial, home healthcare and catering businesses). On the other hand, the fact that Temp. Regs. Sec. 1.45D-1T(d)(4) does not impose a gross-income test when the low-income community tangible property or wages percentage is at least 50%, apparently accommodates pure cost centers such as production and distribution facilities and situations in which cost of sales exceeds sales, notwithstanding the possible existence of some nonqualifying income that otherwise could cause the...